Who Really Pays the Corporate Income Tax?

On his excellent new weblog, Harvard economist N. Gregory Mankiw offers a useful reminder about who actually bears the burden of the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. in society. Hint: it’s not just shareholders:

Who Pays the Corporate Income TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ? The corporate income tax provides a good example of the importance of tax incidenceTax incidence is a measure of who ultimately pays a tax, either directly or through the tax burden. This burden can be split between buyers and consumers, or different groups in the economy. for tax policy. The corporate tax is popular among voters. After all, corporations are not people. Voters are always eager to have their taxes reduced and have some impersonal corporation pick up the tab.

But before deciding that the corporate income tax is a good way for the government to raise revenue, we should consider who bears the burden of the corporate tax. This is a difficult question on which economists disagree, but one thing is certain: People pay all taxes. When the government levies a tax on a corporation, the corporation is more like a tax collector than a taxpayer. The burden of the tax ultimately falls on people—the owners, customers, or workers of the corporation.

Many economists believe that workers and customers bear much of the burden of the corporate income tax. To see why, consider an example. Suppose that the U.S. government decides to raise the tax on the income earned by car companies. At first, this tax hurts the owners of the car companies, who receive less profit. But over time, these owners will respond to the tax. Because producing cars is less profitable, they invest less in building new car factories. Instead, they invest their wealth in other ways—for example, by buying larger houses or by building factories in other industries or other countries. With fewer car factories, the supply of cars declines, as does the demand for autoworkers. Thus, a tax on corporations making cars causes the price of cars to rise and the wages of autoworkers to fall.

The corporate income tax shows how dangerous the flypaper theory of tax incidence can be. The corporate income tax is popular in part because it appears to be paid by rich corporations. Yet those who bear the ultimate burden of the tax—the customers and workers of corporations—are often not rich. If the true incidence of the corporate tax were more widely known, this tax might be less popular among voters.

Source: Principles of Economics, 4th Edition

Share this article